Questions - Ratios

Basic Financial Statement
Analysis
Questions - Financial Ratios
Financial Ratios — Liquidity
Financial Ratios
What is the acid test (or quick) ratio for Sycamore?
Cash $ 10,000 Cash + Marketable Securities + Net Accounts Receivable

Marketable securities 18,000 Accounts Payable + Current Portion of Long-Term Debt
Accounts receivable 120,000
Inventories 375,000
Prepaid expenses 12,000
Accounts payable 75,000 10,000 + 18,000 + 120,000
Long-term debt - current portion 20,000 = 1.56
Long-term debt 400,000 75,000 + 20,000
Sales 1,650,000
Financial Ratios
If a company has a current ratio of 2.1 and pays
off a portion of its accounts payable with cash, the
current ratio will:
Cash $ 10,000
Marketable securities 18,000
Inventories 375,000
Accounts payable 75,000
Long-term debt - current portion 20,000
Long-term debt 400,000
Sales 1,650,000

Financial Ratios
Angle Brugger Industry
Ratio Company Limited Average
Current ratio 3.0 2.1 1.8
Quick ratio 1.6 1.0 1.0
A/R turnover Cash 5.0 6.3 6.0$ 10,000 Average Collection Period in Days = 365 ÷ Accounts Receivable Turnover Ratio
Marketable securities
Inventory turnover 4.1 6.3 5.3 18,000 Days in Inventory = 365 ÷ Inventory Turnover Ratio
Total liability to net worth 2.1 3.0 2.0 Operating Cycle Ratio = Average Collection Period + Days in Inventory
Accounts
Sales to net worth
receivable
15.0 20.0 13.5
120,000
Inventories2.8
Sales to total assets 7.3 5.0 375,000
Prepaid expenses
Net income to sales 2.4% 1.1% 1.6% 12,000
Net income to net worth
Accounts 8.6%
payable 16.5% 9.9% 75,000
Net income to net assets 6.6% 8.2% 7.8%
Long-term
Times interest earned debt4.3 - current
2.6 portion
4.0 20,000
Sales 1,650,000 Ratio Angle Brugger Industry
365 365 365
The operating cycle represents the average time it takes to invest cash in inventory and Average 5
= 73
6.3
= 57.9
6
= 60.8
eventually collect the cash from sales. Collection
If both Angle Company and Brugger Limited make all sales on open account, which of the 365 365 365
following items is most accurate? = 89 = 57.9 = 68.9
Days in 4.1 6.3 5.3
Inventory
Operating 162 115.8 129.7
Cycle
Angle’s operating cycle is about 45 days longer than Brugger’s (46.2 days).
Financial Ratios
A ratio that measures how efficiently a company is utilizing its current assets is:
Cash $ 10,000
Inventories 375,000
Asset utilization
Accounts payableor efficiency ratios are ratios that measure how well a company is utilizing
75,000
its assets by turning the assets into
Long-term debt - current portion 20,000 sales or revenues.
Sales 1,650,000

What is the acid test (orquick) ratio for Sycamore?
Financial Ratios
The quality of accounts receivable

Cashfor a company is not$affected
10,000 by the:
The quality of accounts receivable measures how quickly 375,000
Inventories a
company collects amounts dueexpenses
Prepaid from its customers. 12,000
Average collection period: The length of credit terms for customers does affect the quality of accounts receivable.
Long-term debt - current portion 20,000 If the length of credit terms (days a company has to pay) is long, customers will likely pay towards the end
Net credit salesLong-term
÷ Average net trade receivables 400,000
debt
of the credit term period.
The company’s follow-up procedures on delinquent accounts also have an impact on the quality of accounts
Net trade receivables are computed as total trade receivables less
the allowance forSales 1,650,000 receivables.
doubtful accounts.
The formula already takes into account the receivables that the More intervention on past-due accounts could help collections, and less intervention could negatively
What
companyis does
the not
acid testto (or
expect quick)
collect on. ratio for Sycamore? impact collections.
The company’s credit policies also have an impact on the quality of receivables.
Quality is measured based on the receivables it does expect to
collect. Therefore, the size of the allowance for doubtful accounts Credit policies evaluate the creditworthiness of customers, and if the company extends credit to a customer
with poor creditworthiness, this will have a negative impact on cash collections, which is what receivables
does not affect the quality of accounts receivable. quality is measuring.
Financial Ratios
Assets
Cash $ 50
Marketable Securities 75
AccountsCash
Receivable $ 10,000
175
Inventory
Marketable securities 200
18,000 Current Assets Current Liabilities Current Ratio
Long-Term Investments 250
NetAccounts
Plant Assetsreceivable 1,250 120,000
TotalInventories
Assets $2,000 375,000
Liabilities
Prepaid and Owners’ Equity
expenses 12,000 Accounts Payable + Accrued
Accounts Payable $ 200 Cash + AR + Marketable
Accounts 500,000
Payablespayable 75,000 Payable +
Accrued 50 Securities + Inventory = 1.25
S-T Note Payable
Long-term
Short-Term Notesdebt - current portion
Payable 150 20,000 Befor $50,000 + $75,000 + $175,000
400,000
Long-Term
Long-termDebt debt 300 400,000 e + $200,000
$200,000 + $50,000 +
Common Stock 1,000 $150,000
RetainedSales
Earnings 1,650,000
300 = $500,000
= $400,000
Total Liabilities and Owners’ Equity $2,000
475,000
= 1.27
If Alderwood uses $25 cash to pay $25 of accounts payable, what is 375,000
the new current ratio? $25,000 + $75,000 $175,000 + $50,000 +
+ $175,000 + $200,000 $150,000
After
= $475,000 = $375,000
Financial Ratios
Company A Company B Company C

Net credit sales $175,000 $145,000 $225,000
Cash $ 10,000
Average accounts receivable, net 10,000 20,000 11,500
Average allowance18,000
Marketable securities for uncollectible accounts 3,500 6,500 4,500
Inventories 375,000
If each of the companies has credit terms of net 30 days, the financial analyst is most likely to conclude which one of the
Prepaid expenses 12,000 following?
Sales ratio that measures the
Average collection period is an activity 1,650,000
average
number of days needed to collect trade accounts receivable.
What
It measures how is the
rapidly thefirm's
acidcredit
testsales
(orarequick) ratio (the
being collected for Sycamore? 0
Company Company Company
lower the ratio, the more efficient the collection). A B C
Net Credit Sales 175000 145000 225000
Average Net AR 10000 20000 11500
Average Collection
Period 17.5 7.25 19.57
(Net Credit Sales ÷ Average AR)
Average Collection 2e+01 5e+01 2e+01
Period (Days)
Since receivables are already shown “net”, we do not need to consider the
allowance for doubtful accounts.
Financial Ratios
Financial Ratios — Liquidity Current Assets Current Liabilities Current Ratio
740,000
Cash + AR + Inventory +
Accounts Payable + Interest = 5.29
Prepaid Expenses 140,000
Payable + Notes Payable
Befor $100,000 + $200,000 +
$80,000 + $10,000 + $50,000
e $400,000 + $40,000
Cash $ 10,000 = $740,000
= $140,000
Accounts receivable $200,000 18,000
Accounts receivable
Accounts payable 80,000 120,000 700,000
Bonds payable, due in 10 years
Inventories 300,000 375,000 =7
Cash 100,000 100,000
Interest payable, due in three months 10,000
Inventory Accounts payable 400,000 75,000
Land Long-term debt - 250,000current portion 20,000 $60,000 + $200,000 $40,000 + $10,000
+ $400,000 + $40,000 + $50,000
Long-term
Notes payable, due debt
in six months 50,000 400,000 After Quick Assets Quick Liabilities Quick Ratio
Prepaid expensesSales 40,000 1,650,000 = $700,000 = $100,000

The company has an operating cycle of five months. 300,000
Accounts Payable + Interest = 2.14
What will happen to the current ratio and quick ratio if CPZ Enterprises Cash + AR 140,000
Payable + Notes Payable
uses cash to pay 50% of the accounts payable? Befor $100,000 + $200,000
$80,000 + $10,000 + $50,000
e
= $300,000
= $140,000
260,000
= 2.6
100,000
Financial Ratios
Financial Ratios — Leverage
Product quality and pricing do not appear in the data shown,

Cash $ 10,000 so we would assume that Borglum has addressed these
Bond Rockland Western Industry issues.
Marketable------securities 18,000
-------- ------- --------
Accounts receivable
Total sales (millions) $4.27 $3.91 $4.86 120,000
$4.30
Of the data given, all three prospects appear similar and all
Net profit margin Inventories
9.55% 9.85% 10.05% 375,0009.65% match up well with industry averages (except for Bond's
Current ratioPrepaid expenses
1.32 2.02 1.96 12,000
1.95 current ratio).
Return on assets 11.0% 12.6% 11.4% 12.4% Rockland's debt/equity and degree of financial leverage seem
Debt/equity ratio
Accounts payable
62.5% 44.6%
75,000
49.6% 48.3% to indicate that this firm has not overused borrowing. Both
Financial Long-term
leverage debt
1.40- current
1.02 portion
1.86 20,000
1.33 compare well with the other two firms and the industry
Long-term debt 400,000 averages.
Sales
Borglum's objective for this acquisition is assuring a steady source1,650,000
of supply from a stable company. Borglum should acquire Rockland as both the debt/equity
Based on the information above, select the strategy that would fulfill Borglum's objective: ratio and degree of financial leverage are below the industry
What is the acid test (or quick) ratio for Sycamore? average.
Financial Ratios
Which one of the following statements concerning the effects of leverage on

Cash earnings before$ interest
10,000and taxes (EBIT) and earnings per share (EPS) is
Marketable securities 18,000 correct?
Inventories For a firm using debt financing, a decrease in EBIT will result in a
375,000
Prepaid expenses proportionally
12,000 larger decrease in EPS.
Degree of financial leverage
Accounts payable 75,000 is the percentage change in earnings available to
common shareholders related to the change in earnings before interest and
Long-term debt - current portion 20,000taxes (EBIT).
Long-term debt 400,000per share (EPS) will go up. If EBIT goes down,
If EBIT goes up, earnings
Sales 1,650,000
shareholder earnings (EPS) will go down also.
Financial Ratios
The Davis Company has a short-term cash need and plans to take out a 120-
day promissory note. What effect will this transaction have on the long-term
Cash $ 10,000 ratio and the equity to total debt ratio?
debt-to-equity
Inventories 375,000
Prepaid expenses Long-term
12,000debt to equity capital: No change
Accounts payableSince a 120-day75,000
promissory note would be a current liability, the long-
Long-term debt - current portion
term debt20,000
to equity capital ratio would not be affected.
Equity to total debt: Decrease
Sales 1,650,000
The equity to total debt ratio would decrease, since the denominator
would increase and the numerator would remain unchanged.
Financial Ratios
The Cash
use of debt in the capital structure
$ 10,000 of a firm:
Increases its financial leverage.
Inventories 375,000
Financial leverage is the amount of debt financing
related to the amount of equity financing.
Accounts payable On the plus75,000
side, borrowing at low interest rates and
Long-term debt - current portion
investing20,000
those funds at a higher rate produces
Long-term debt enhanced400,000
profits. However, the opposite could also
Sales 1,650,000 occur.
Another consideration is that higher levels of debt
What is the acid test (or quick) create
ratio potential
for Sycamore?
risk for the borrowing company.
Financial Ratios
Cash $ 10,000
For 20X1, Nelson Industries increased earnings before interest and taxes by
17%. During the same period, net income after tax increased by 42%. The
Accounts receivable degree of120,000
financial leverage that existed during 20X1 is:
Inventories 375,000
Long-term debt - current portion 20,000 Percent Change in Net Income 42
Long-termDegree
debt of Financial Leverage
400,000= Percent Change in Operating Income = 17 = 2.47
Sales 1,650,000

Financial Ratios
Financial Ratios — Activity
Interstate Motors has decided to make an additional investment in its operating

assets, which are financed by debt. Assuming that all other factors remain
constant, this increase in investment will have which one of the following
effects?
Cash $ 10,000
Inventories 375,000 The question states that “all other factors remain constant.”
Prepaid expenses 12,000 Therefore, consider only the increase in operating assets and the
Gross margin ratio is gross margin over net sales revenue where gross
increase in liability; depreciation is not a consideration in this
question.
margin is net sales Long-term
revenue less debt - current
cost of portion 20,000
goods sold.
Sales 1,650,000 The gross margin ratio will not change, since assets and liabilities
No Change do not affect this ratio.
Operating assets are those assets that generate revenue.
What is the acid test (or quick) ratio for Sycamore? The operating asset turnover will decrease, since the denominator
(operating assets) increases with the purchase and the numerator
Decrease (net sales) remains the same.
Net income is revenue less all expenses, including interest and taxes. The return on operating assets will decrease, since the
denominator (operating assets) increases with the addition of the
Decrease new assets and the numerator (net income) remains the same.
Financial Ratios
Assets 20X2 20X1

Current assets
Cash $ 45 $ 38
Trading securities 30 20
Accounts receivable (net) 68 48
Cash $ 10,000
Inventory 90 80
Prepaid expenses 22 30
Total current assets 255 216
Accounts receivable Net120,000
sales $480 $460
Inventories 375,000 Costs and expenses
Cost of goods sold 330 315
Selling, general, and administrative 52 51
Interest expense 8 9
Sales Devlin Company's inventory turnover for the year ended May 31, 20X2, was:
1,650,000

Cost of Goods Sold
Inventory Turnover =
Average Inventory
330,000
Inventory Turnover = = 3.88
(90,000 + 80,000) ÷ 2
Financial Ratios
Calculate Rich Co.'s total

Cash asset turnover with the following
$ 10,000 information:
Net sales
Accounts receivable $ 2,000,000
120,000
Total assets, 12/31 Year
Inventories 2 3,500,000
375,000
Total assets, 12/31 Year
Prepaid expenses 1 2,900,000
12,000
Net income 55,000,000
Sales 1,650,000 Generated sales of $0.625 per
Net Sales 2,000,000 dollar of total assets.
Total Asset Turnover = = = 0.625
What is the acid test (or quick) ratioAverage
for Sycamore?
Total Assets (3,500,000 + 2,900,000) ÷ 2
Financial Ratios
Net sales $900,000

Cost of goods sold
Inventory - beginning $125,000
Purchases 540,000
--------
Cash $ 10,000Goods available for sale 665,000
Inventory - ending 138,000
Marketable securities 18,000 --------
Accounts receivable 120,000 527,000
--------
Inventories 375,000Gross profit 373,000
Operating expenses 175,000
Accounts payable 75,000 --------
Income from operations $198,000
Sales Garland's inventory turnover ratio is:
1,650,000

Cost of Goods Sold
Inventory Turnover =
Average Inventory
527,000
Inventory Turnover = = 4.01
(125,000 + 138,000) ÷ 2
Financial Ratios
Cash In computing $ 10,000

inventory turnover, the preferred base to use is the:
Inventories In computing inventory
375,000turnover, the preferred base to use is the cost of
sales base because
Prepaid expenses it eliminates any change due solely to sales price
12,000
Accounts payable 75,000 changes.
If the sales
Long-term debt - current base were
portion used, the inventory turnover could be easily
20,000
Long-term debt manipulated
400,000 by changing the sales prices.
Sales 1,650,000

Financial Ratios
Financial Ratios — Profitability
A company had $5 million in sales, $3 million in cost of goods sold, and $1 million in
Cashselling and administrative expenses during the last fiscal year. If the company’s income
$ 10,000
Marketable tax rate was 25%, what
securities was the company’s gross profit margin percentage?
18,000
Inventories 375,000
Long-term debt
Cost of -sales
current portion
is often analyzed20,000
using the gross profit margin (GPM), which measures the
Long-term debtproportion of each 400,000
sales dollar remaining after covering cost of sales.
Sales Gross profit is sales 1,650,000
– cost of goods sold, and the GPM is gross profit divided by sales.
Income taxes are not part of the equation. For this company, the GPM is 40% ($5,000,000 –
What is the acid test (or quick) ratio for3,000,000)
Sycamore? ÷ $5,000,000).
Gross Pro t = Sales - COGS
fi
Gross Pro t (5,000,000 - 3,000,000)
Gross Pro t Margin = = = .40
fi
Sales 5,000,000
fi
Financial Ratios
effectively using leverage, which of the following ratios is likely$to10,000

Cash be the largest?
Financial leverage is measured by the extent to which the assets of the
firm are financed with debt, which Inventories
requires a fixed cash payment. 375,000
As the EFFECTIV
Prepaid expensesthe excess goes to12,000 PROFITABLE
firm earns profits in excess of these fixed payments, the E
LEVERAG
commonAccounts payable
shareholders. 75,000 E Assets financed
Therefore, if a company is profitable and isdebt
Long-term effectively usingportion
- current leverage, it20,000 with debt
will have a high return on common equity because
Long-term debt higher leverage 400,000
effectively used means a lower need for equity and therefore a lower FIXED CASH
Sales 1,650,000 PAYMENTS
denominator for return on equity, leading to an increased return on equity.
This is the ratio which indicates the return to common shareholders for
Whattheir
is investment
the acidintest (or quick) ratio for
the firm. Sycamore?
The return on investment, also called the return on total assets, indicates Profits in excess goes to
the return to the firm on the total investment, debt and equity. The return COMMON SHAREHOLDERS
on total shareholders' equity indicates the return to all shareholders, High return on COMMON EQUITY because
common and preferred; however, preferred stock has some elements of higher leverage effectively used means a lower
need for equity and therefore a lower denominator
debt (i.e., fixed cash payments) and is often considered part of the for return on equity, leading to an increased return
financial leverage of the firm. on equity.
Financial Ratios
Assets 20X2 20X1

Current assets
Cash $ 45 $ 38
Trading securities 30 20
Accounts receivable (net) 68 48
Inventory 90 80
Cash
Prepaid expenses $ 10,000
22 30
Total current assets
---- ----
255
18,000
216
Accounts
Investments, atreceivable
equity 38 120,000
30
Property, plant, and equipment (net) 375 400
Inventories
Intangible assets (net) 80375,000
45
Prepaid expenses
Total assets
---- ----
$748 $691
12,000
Accounts payable 75,000 Return on Assets =
Net Income
=
54,000
= 0.075
Long-term debt - current 20X2 portion20X1 20,000 Average Total Assets (748 + 691) ÷ 2
Net sales $480 $460
Long-term debt
Costs and expenses 400,000
Sales
Cost of goods sold
Selling, general, and administrative
1,650,000
330
52
315
51
Interest expense 8 9
What is the acid test (or
Income before taxes
quick) ratio
---- ---- for Sycamore?
90 85
Income taxes 36 34
---- ----
Net income $ 54 $ 51
Devlin Company's rate of return on assets for the year ended May 31, 20X2, was:
Financial Ratios
Cash Anderson Cable$ 10,000

wishes to calculate their return on assets. You know
that the return on 18,000
equity is 12% and that the debt ratio is 40%. What
is the return on assets?
Inventories 375,000
Return on Assets = Return on Equity × (1 - Debt Ratio)
= 0.12 × (1 - 0.40) = 0.072
Sales 1,650,000

Financial Ratios
6/30/X2 6/30/X1
Preferred stock - 5% cumulative, $100 par,
Cash nonparticipating, authorized,
$ 10,000
issued
and securities
Marketable outstanding, 2,000 shares 18,000 200 200
Common stock - $10 par, 40,000 shares
Accountsauthorized,
receivable 120,000
30,000 shares issued and outstanding 300 300
Inventories 375,000
Additional paid-in capital - common 150 150
PrepaidRetained
expenses earnings
12,000 130
------ ------
100
Accounts Total
payable
shareholders' equity 75,000 780 750
Long-term debt - current portion ------ 20,000------
Total liabilities and shareholders' equity $1,000 $ 910
Sales 1,650,000
What is the acid testAssuming

(or quick) ratio
that King for Sycamore?
Products Corporation's net income for the year ended June 30,
20X2, was $70,000 and there are no preferred stock dividends in arrears, King
Products' return on common equity was:
Net Income - Preferred Dividends 70,000 - (.05 × 200,000) 70,000 - 10,000

Return on Common Equity = = = = .106
Average Common Stockholders' Equity .5 × (780,000 - 200,000 + 750,000 - 200,000) 565,000
Financial Ratios
The common stock of a beverage company has a current market price of $34. The beverage
company is estimated to $earn
Cash $2 per share in the next year. The average price/earnings ratio
10,000
of companies
Marketable securities in the beverage industry is 15. Using the price/earnings ratio as the
18,000
comparable valuation
Accounts receivable 120,000method, the beverage company’s stock is:
Inventories 375,000
Accounts payable
The price-earnings 75,000
(P/E) ratio is used in valuing a company and compares its current share
Long-term
pricedebt - current
(or market portion
value) 20,000
to its earnings-per-share.This ratio is also called the price multiple or
Long-term debt 400,000 earnings multiple.
Sales
The P/E ratio basically 1,650,000
indicates the dollar amount an investor should invest in a company in
order to earn one dollar of that company’s earnings.
What is the acidThe
test (or P/E
current quick)
ratio isratio for÷Sycamore?
$17 ($34 $2.00 = $17). If the industry P/E ratio is $15, the average
market price for the industry is $30 ($15 × $2.00), making the beverage company’s stock $4
($34 - $30) overvalued.
Financial Ratios
Inventory
Accounts
150.000000
Payable
150.000000USD USD
Short-term
Balance Sheet Other Current Assets debt
500.000000USD 0.000000U
SD
Inventory $1,000 Accounts payable $ 100 1300.00000
Other current assets 500 Short-term debt 900 Fixed Assets Equity
800.000000USD
0USD
Fixed assets 800 Equity 1,300
------ ------ Total Liab.
Total assets $2,300 Total liab. and equity $2,300 1450.00000
====== Cash ====== $ 10,000 Total Assets And Equity 0USD
1450.000000USD
Income Statement
18,000
Sales $5,000
Inventories 375,000 Sales 5000.000000USD
Operating expenses 4,500
EBIT
Prepaid ------expenses
500
12,000 Net Income
Accounts90payable
Interest expenses 75,000 Return on Assets =
------ Operating Expenses Average Assets
4500.000000USD
EBT Long-term 410debt - current portion 20,000
Tax Long-term 164 debt
------
400,000
Net income Sales$ 246 1,650,000 EBIT 300
500.000000USD
= 20.7
1,450
The Saver Company is considering implementing a JIT inventory system that other companies in the
industry have had success with. If they do so, they expect that the inventory level will drop to $150, Interest Expenses 0.000000USD
that the company will be able to finance the entire inventory through accounts payable, and that they
will also be able to eliminate short-term debt. The company proposes to do the following: ROA increased due to:
Keep all assets other than inventory at their present levels. lower interest expense & higher net income.
EBT
1.
Inventory will decrease to $150. 500.000000USD

2. decreases in total assets.
Accounts payable will increase to $150. Total assets changed on the first of the new fiscal year; therefore, an
Short-term debt will be eliminated. average is not needed (average and ending assets both $1,450)
Assume that the tax rate is 40% and EBIT (earnings before income taxes) will remain unchanged. If
these proposed changes occur, what will the company's ROA be (assuming that all changes take effect Tax 200.000000USD
on the first day of the new fiscal year)?
Net Income 300.000000USD

Financial Ratios
20X2 20X1
------- -------
Shareholders' equity
Common stock, no par,
10,000,000 shares $25,000 $25,000
Retained earnings
Cash 69,000 50,000
$ 10,000
Credit sales 200,000 140,000
Marketable
Cost of goods sold securities
120,000 80,00018,000
Selling andAccounts receivable
administrative expenses 38,000 120,000
30,000
Interest expense 2,000 2,000
Inventories
Income tax expense 15,000
375,000
11,000
Sawyer Corporation's return on shareholders' equity for the year ended November 30, 20X2, is:
Sales 1,650,000
Sales 200000USD
COGSWhat 120000USD
is the acid test (or quick) ratio for Sycamore?
20X2 20X1 Average Return on
SG&A 38000USD
Common Stock 25000USD 25000USD
Shareholders’ Equity
Expense Retained Earnings 69000USD 50000USD 25000U
Interest Net Income SD
2000USD Shareholders’ Equity 94000USD 75000USD 84500USD
Expense Average 84500U
Tax Expenses 15000USD Shareholders’ Equity SD
Net Income 25000USD 29.585800%

Financial Ratios
For a given level of sales, and holding all other financial statement items constant, a
Cash company's return on equity (ROE) will:
$ 10,000
Inventories 375,000
Prepaid expenses 12,000 as their total assets increase.
Decrease
As total assets
Long-term increase,
debt ROEportion
- current will decrease if all other financial statement items are held constant because the
20,000
increase in assets
Long-term will be associated400,000
debt with a matching increase in stockholders' equity, given that assets equal
Sales liabilities plus stockholder’s equity.
1,650,000
ROE will decrease, not increase, as the debt ratio decreases. Given that assets equal liabilities plus stockholder’s equity, as debt decreases, the
funding provided by stockholder’s equity increases, lowering ROE.
ROE will increase as COGS (cost of goods sold) as a percentage of sales decreases because the main driver of the denominator, net income, will
increase, causing an increase in ROE.
ROE will decrease as equity increases because the denominator, average common equity, would increase, creating a smaller ratio holding sales and
net income constant.
Financial Ratios
Financial Ratios — Market
Birch Corporation had net income for the year of $101,504 and a simple
capital structure consisting of the following common shares outstanding. Fraction
Cash $ 10,000 Weighted Shares
Marketable securities 18,000 Months Shares
Accounts receivable
Months Outstanding Number of Shares 120,000
------------------
Inventories---------------- 375,000 Portion of Year Weighted
January-February
Prepaid expenses 24,000 12,000 Outstanding Shares
March-June 29,400
Accounts payable
July-November 36,000 75,000
Long-term debt - 35,040
December current portion 20,000 Jan - Feb 24000 2/12 4000

Sales 1,650,000 Mar - Jun 29400 4/12 9800
Birch Corporation's earnings per share (rounded to the nearest cent) were:
Jul - Nov 5/12
What is the acid test (or quick) ratio for Sycamore? 36000 15000
Dec 35040 Earnings Per 1/12 2920
Share
Weighted
Average Net Income 101504USD
31720
Number of WACS 31720
Shares EPS 3.200000U

SD
Financial Ratios
Baylor Company paid out one-half of its 20X1 earnings in dividends. Baylor's
earnings increased by 20%, and its dividend increased by 15% in 20X2.
Cash $ 10,000
Baylor's dividend payout
Accounts ratio for 20X2 was: 120,000
receivable
Inventories 375,000
Prepaid expenses 0.50
12,000 (0.50) (1.15) 0.575
Accounts
20X1 Dividend payable
Payout Ratio = 75,000 20X2 Dividend Payout Ratio = = = 0.479
1.00 (1.00) (1.20) 1.20
Sales 1,650,000

Dividend Payout Ratio is the
Dividend per Common Share
proportion of earnings paid out as Dividend Payout Ratio =
dividends to shareholders. EPS
Cash dividends paid on common stock

Net income - Preferred dividends
Financial Ratios
All of the following are true except:

Cash $ 10,000
Inventories 375,000
a dividend payout ratio greater than 100% would attract investors
Prepaid expensesinterested in immediate
12,000 cash flow from their investments.
A company that paid out more than 100% of net income as
Long-term debt - currentcash
portion 20,000
dividends is paying out dividends with funds that were
not provided by operations.
Sales More1,650,000
than likely an organization could not keep up the
payment of such dividends for any length of time;
What is the acid test (or quick) ratio most
therefore, for Sycamore?
investors who desired good cash flow from
their investment would not be interested in purchasing
stock in such an organization.
Financial Ratios
Operating income $800,000

Interest expense 100,000
Income before income taxes $700,000
Cash $ 10,000
Income tax expense 210,000
Marketable securities Net income
18,000 $490,000
Inventories 375,000
Accounts payable The times 75,000
interest earned ratio is:
Sales 1,650,000

EBIT
Times Interest Earned =
Interest Expense
490,000 + 210,000 + 100,000

= 8:1
100,000
Financial Ratios
Per Share
Book value at December 31 $12.00
Cash $ 10,000
Quoted market value on NYSE on December 31 9.00
Earnings for the 18,000
Marketable securities year 3.00
Par value
Accounts receivable 120,000 2.00
Dividend for the year 1.00
Inventories 375,000
Accounts payable What was75,000
the price-earnings ratio on common stock for the year?
Sales 1,650,000

Price-Earnings Ratio =
Market Price of Stock 9.00
=3
EPS 3.00
Financial Ratios
Preferred shares (5%, $100 par) outstanding throughout 20X1 100,000

Common shares ($50 par) outstanding January - April 200,000
Common shares ($50 par) outstanding May - December 300,000
Cash $ income
Net 10,000for 20X1 $1,000,000
Inventories 375,000
What was the basic earnings per share (rounded to nearest cent) for 20X1?
Sales
Number of 1,650,000
Portion
Month outstandin WACS
What is the acidg test (or
shares
quick) ratio
of Month for Sycamore?
Net Income 1000000USD
Jan - Apr 4000 4/12 1333.33
May - Dec 6000 8/12 4000
WACS 533333.000000USD Preferred Dividends 5000USD
Net Income Available to Common Shareholders 995000USD

Financial Ratios
Financial Ratios — Market Cash
Receivables
$ 200
270
Inventory 600
Sales $2,400 Total Current Assets $1,070
Cost of Goods Sold 1,834 Plant Assets 1,200
Gross Margin $ 566 Total Assets $2,270
Selling Expenses 200 ======
Administrative Expenses 191 Accounts Payable $ 245
Earnings Before Interest and Taxes $ 175 Notes Payable 400
Cash Interest Expense $ 10,000 35 Other Current liabilities 100
Income
Marketable Before Taxes
securities $ 140
18,000 Total Current Liabilities $ 745
Income Taxes 56 Long-Term Liabilities 420
Accounts receivable
Net Income 120,000
$ 84 Common Stock 1,000
Inventories 375,000 Retained Earnings 105
Prepaid expenses 12,000 Total Liabilities and Equity $2,270
Sales that Holbrook had an
Assume 1,650,000
average of 20,000 shares outstanding during 20X3 and the stock price
on December 31, 20X3, was $30.00. Calculate the price-earnings ratio and the price-to-book ratio for
What is the Holbrook.
acid test (or quick) ratio for Sycamore?
Number of Price-to-Earnings
Book Price-to- EPS
Equity outstandin Ratio
Value Book Ratio
g shares
1105.000000USD 20 55.250000USD 0.542986

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Basic Financial Statement

Cash $ 10,000 Cash + Marketable Securities + Net Accounts Receivable

What is the acid test (or quick) ratio for Sycamore?

The quality of accounts receivable

Company A Company B Company C

Average Net AR 10000 20000 11500

What is the acid test (or quick) ratio for Sycamore?

Product quality and pricing do not appear in the data shown,

Which one of the following statements concerning the effects of leverage on

What is the acid test (or quick) ratio for Sycamore?

Interstate Motors has decided to make an additional investment in its operating

Assets 20X2 20X1

What is the acid test (or quick) ratio for Sycamore?

Calculate Rich Co.'s total

Net sales $900,000

What is the acid test (or quick) ratio for Sycamore?

Cash In computing $ 10,000

What is the acid test (or quick) ratio for Sycamore?

Gross Pro t = Sales - COGS

effectively using leverage, which of the following ratios is likely$to10,000

Assets 20X2 20X1

Cash Anderson Cable$ 10,000

What is the acid test (or quick) ratio for Sycamore?

What is the acid testAssuming

Net Income - Preferred Dividends 70,000 - (.05 × 200,000) 70,000 - 10,000

Inventory will decrease to $150. 500.000000USD

Net Income 300.000000USD

Net Income 25000USD 29.585800%

What is the acid test (or quick) ratio for Sycamore?

Long-term debt 400,000

Dec 35040 Earnings Per 1/12 2920

Shares EPS 3.200000U

What is the acid test (or quick) ratio for Sycamore?

Cash dividends paid on common stock

All of the following are true except:

Operating income $800,000

What is the acid test (or quick) ratio for Sycamore?

490,000 + 210,000 + 100,000

What is the acid test (or quick) ratio for Sycamore?

Preferred shares (5%, $100 par) outstanding throughout 20X1 100,000

May - Dec 6000 8/12 4000

WACS 533333.000000USD Preferred Dividends 5000USD

Net Income Available to Common Shareholders 995000USD

1105.000000USD 20 55.250000USD 0.542986

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